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Financial Ratios
A Ratio refers to a figure calculated as a reference to the relationship of two or more numbers and can be expressed as a fraction, proportion, percentage, or the number of times. When the number is determined by taking two accounting numbers derived from the financial statements, it is termed as the accounting ratio.
Return on Equity
The Return on Equity (RoE) is a measure of the profitability of a business concerning the funds by its stockholders/shareholders. ROE is a metric used generally to determine how well the company utilizes its funds provided by the equity shareholders.
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A firm that has employed no debt in its capital structure in the past is considering financing a major investment programme of €1m. The firm examines two ways of financing – either by the issue of new shares or by issuing debentures. It has been advised by its merchant bankers that the bonds could be arranged at an interest rate of 10 per cent. The alternative would be an issue of equity of 250,000 shares at €4 per share. This would increase the number of shares outstanding from 500,000 to 750,000. After implementing the investment programme the firm expects earnings before interest and tax of €900,000. Given a tax rate of 35 per cent:
Ques1) Calculate earnings per share for the debt and equity financing options at the expected earnings.
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- The major function of investment banks is to help firms to finance via issuing debt or equity. Assume that there are no other costs and expenses. 1) An investment bank agrees to underwrite a $50 million, 10-year, 8 percent coupon par bond issue for a company on a firm commitment basis. The investment bank pays the company on Monday and plans to begin a public sale on Tuesday. If interest rates rise by 0.25 percent, overnight, what will be the impact on the profits of the investment bank?Barry's Ltd. is all equity financed with 18,000 shares outstanding and each share sells for $22. The EBIT of the company is $50,000. The company is debating of converting into a 40% debt capital structure, with 6% interest per annum. The cost of capital is currently 10%. Ignore taxes. You are required to answer the following: (a) What is the current market value of the company? (b) What is the market value of debt in the proposed debt capital structure? (c) How many shares must be repurchased in the proposed levered company?The Blue Boat Company currently has 2 million shares of common stock outstanding, along with RM 5 million in 10% bonds. The firm is considering a RM 10 million expansion program which will be financed with either: (1) all common stock at RM 50 a share, or (2) all bonds at a 12% interest rate. The tax rate is 28%. i. Find the EBIT indifference level associated with two financing proposals. ii. Prove that the EPS will be the same regardless of the plan chosen at the EBIT level found in part (I) above. iii. If the projected level of EBIT is RM 20 million, which alternative will yield a higher EPS?
- Syndicate Ltd. is re-evaluating the rate of return demanded by its investors for new projects with the following projects being reviewed by the board for possible investment: Investment Investment Cost ($) Rate of Return (%) A 1,500,000 15 B 2,000,000 12 C 5,000,000 9 D 750,000 6 The latest balance sheet for Syndicate Ltd shows: Long Term Debt Book Value ($) Bonds: Issued at par: $100 5,000,000 Annual coupon of 6% 4 years to maturity Equity Preference Shares: 1,000,000 100,000 shares issued Ordinary Shares: 4,000,000 1,000,000 shares issued The company’s bank has advised that…Syndicate Ltd. is re-evaluating the rate of return demanded by its investors for new projects with the following projects being reviewed by the board for possible investment: Investment Investment Cost ($) Rate of Return (%) A 1,500,000 15 B 2,000,000 12 C 5,000,000 9 D 750,000 6 The latest balance sheet for Syndicate Ltd shows: Long Term Debt Book Value ($) Bonds: Issued at par: $100 5,000,000 Annual coupon of 6% 4 years to maturity Equity Preference Shares: 1,000,000 100,000 shares issued Ordinary Shares: 4,000,000 1,000,000 shares issued The company’s bank has advised that…Brooks Corporation is financed with $32 million of 9% debt and $68 million of common equity. The firm has 1 million shares of common stock outstanding. Brooks needs to raise $25 million and is undecided between two possible plans for raising this capital:Plan A: Equity financing. Under this plan, common stock will be sold at $62.50 per share.Plan B: Debt financing. Under this plan, 11% coupon bonds will be sold.At what level of operating income (EBIT) will the firm be indifferent between the two plans? Assume a 34% marginal tax rate.
- ABC SA. is financed solely by equity. Currently, the company has 20 million sharesoutstanding. These shares are listed in Euronext at 10€/share. The executive management teamannounced the aim of issuing 40 million euros in debt and using the proceeds to buy own shares(a share buyback program).a) What consequences on the market price do you anticipate, because of this announcement(provide the corresponding rationale for your answer)?b) How many shares can the company buy back with the proceeds from the debt issue?c) Following the change in financial structure, what will be the company’s market value (equityplus debt)?d) What level will the debt ratio reach after the change in financial structure?e) With this change in financial structure, is the cost of equity expected to increase, decrease,or stay at the same level? Justify.Yamhash, Inc. is also evaluating its costs of capital under alternative financing arrangements. Inconsultation with investment bankers, Yamhash expects to be able to issue bond at par with a coupon rateof 8% and to issue new preferred stock with Rs.2.50 per share dividend at Rs.25 a share. The commonstock of Yamhash is currently selling for Rs.20 a share. Yamhash expects to pay a dividend of Rs.1.50per share next year. Market analysts foresee a growth in dividends in Invest stock at a rate of 5% per year.Yamhash marginal tax rate is 35%. Calculate costs of capital.Twin City Publishing is considering two financial alternatives for financing a major expansion program. Under either alternative EBIT is expected to be $15.6 million. Currently the firm's capital structure consists of 4 million shares of common stock and $35 million in 11% long-term bonds. Under the debt financing alternative $10 million in 12% long-term bonds will be sold and under the equity financing alternative the firm would sell 500,000 shares of common stock. The P/E (Price-earnings ratio) under the debt alternative would be 15 and the P/E under the equity alternative would be 16. The firm's tax rate is 40%. Required: Which alternative would the firm choose? Show your workings and explain your findings.
- Tireless Wheels Limited has no debt financing and has a value of $60 millionand EBIT of $25 million. The firm is planning to change its capital structureby issuing $30 million in debt, and repurchasing requisite number of shares.The firm is estimated to pay 8 percent on interest expense. Its income istaxed at a per annum rate of 30%. a) What is the firm’s unlevered cost of equity?b) What is the firm’s levered cost of equity?c) What will be the firm’s WACC after the recapitalization?d) What change do you observe in the firm’s WACC before and afterrecapitalization? Why?Executive Cheese has issued debt with a market value of $100.56 million and has outstanding 15.60 million shares with a market price of $10 a share. It now announces that it intends to issue a further $55.44 million of debt and to use the proceeds to buy back common stock. Debtholders, seeing the extra risk, mark the value of the existing debt down to $60 million. c-1. What is the market value of the firm (equity plus debt) after the change in capital structure? (Do not round intermediate calculations. Enter your answer in millions. Round your answer to 2 decimal places.) d. What is the debt ratio after the change in structure? (Do not round intermediate calculations. Round your answer to 2 decimal places.) e. Who (if anyone) gains or loses?The finance director of Netra co wishes to estimate what impact the introduction of debt finance is likely to have on the company’s overall cost of capital. The company is currently financed only by equity. Ordinary Shares ( 25 cents par value ) 500,000 Reserves 1,100,000 Total Equity 1,600,000 The company’s current share price is 420 cents, and up to $4 million of fixed rate five year debt could be raised at an interest rate of 10% per year. The corporate tax rate is 33%.The current earnings before interest and tax are $2.5 million. These earnings are not expected to change significantly for the foreseeable future. The company is considering raising either: a) $2 million in debt finance; or b) $4 million in debt finance In either case the debt finance will be used to repurchase ordinary shares. Required: i) Using Modigliani and Miller’s model in a world with corporate tax, estimate…
